REFINANCE

HOW IT WORKS

Refinancing is the process of obtaining a new loan to fund and pay off an existing loan. A simplified refinance scenario to help better understand the concept of a home refinance is the following: You obtain a $20,000 personal loan from Bank A that carries a 8% yearly interest rate and is amortized over a 5 year period, that is, you will be required to make 60 monthly payments (5 years) on principal and interest. A few months after obtaining the personal loan from Bank A, you find that Bank B is offering personal loans that only carry a 4% yearly interest rate, which also, is amortized over a 5 year period.  In this made-up scenario, the benefit to “refinance” will save you a difference of 4% in interest paid over the life of the loan. If you decide to refinance then Bank B will directly pay off your existing personal loan with Bank A, and by doing so, you will now have a new personal loan with Bank B at a 4% interest rate and the next 60 monthly payment will be due to Bank B moving forward.

 

REFINANCING WITH BANK (B) HAS A $2,232 SAVINGS!

Bank (A)

Loan Amount: $20,000

8% Interest Rate

5 Year Term: 60 Monthly Payments

Total interest cost over life of loan: $4,331

Bank (B)

Loan Amount: $20,000

4% Interest Rate

5 Year Term: 60 Monthly Payments

Total interest cost over life of loan: $2,099

Here are reasons homeowners choose to refinance:

 

Lower rates: If mortgage rates decline, homeowners can take advantage by refinance into a lower interest. Refinancing into a lower interest rate reduces the monthly mortgage payment and decreases the amount of interest the borrower pays over the life of the new mortgage. 

Eliminate or reduce mortgage insurance: Both – FHA and conventional loans – require mortgage insurance. If a homeowner has 20% equity, mortgage insurance could be eliminated by refinancing. Even if 20% equity has not been established, equity above 10% will have a lower mortgage insurance payment. 

Change loan duration:  A shorter loan duration to pay less interest over the life of the loan & own the home outright quicker; lengthen the duration to lower monthly payments.

Cash out home equity:  Homeowners can extract equity from the homes by opting for a cash-out refinance. If the home has sufficient equity, the homeowner can extracted equity to pay for home repairs or major home improvements the interest expense may be tax deductible.

Change loan structure:  Borrowers who used an ARM to make initial payments more affordable could switch to a fixed-rate loan after they built up equity. 

Refinance Closing Fees

Just like a home purchase, refinancing will incur closing fees. However, refinance closing fees will be significantly less than home purchase closing fees. Most lenders allow closing fees on a refinance to be added to the new loan amount. The only out-of-pocket expenses a borrower will incur are the appraisal and credit report fee. Depending on the loan amount, below is list a borrower will  incur in closing fees:

Prepaid fees” are not a real cost but are advance payments made to the bank to hold in an “impound account,” where the bank will use those funds to make payments on your behalf for property taxes and homeowner’s insurance. An impound account is required if the borrower has an FHA home loan and/or a conventional home loan on a property that has less than 20% equity. A borrower may opt to not have an impound account when their is sufficient equity – 20% or higher.